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Limited Liability Company (LLC)
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Posted On: Tuesday August 7th, 2007 at 11:00am EDT
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The Limited liability company (LLC) provides the desired limited liability while avoiding some of the drawbacks (like double taxation and excessive paperwork). Its is a relatively new form of business organization that is worth a serious look. However, the LLC is not available in all states so be certain to find out how your state's law applies. The legal status of the LLC (to date) is indeterminate in many jurisdictions.
The LLC allows for multiple owners, or members. Additionally, there is a managing member, who also enjoys the rewards of limited liability and is typically the person responsible for managing the business. (However, if the LLC has just one owner, it will be taxed as a sole proprietorship.) The profits or losses of the business pass directly through to the owner's personal income tax return, Form 1040. The LLC files a Form 1065, and then lists each member's taxable profit on Form K-1. The bottom-line profit of the business is not considered to be earned income to the members, and therefore is not subject to self-employment tax. But keep in mind that the managing member's share of the bottom-line profit of the LLC is considered earned income, and therefore is subject to self-employment tax.
Members are compensated using either distributions of profit or guaranteed payments. A distribution of profit allows each member to pay themselves by merely writing checks--whenever they need the money (provided the business has the available cash). However, as a member of an LLC, you are not allowed to pay yourself wages. Guaranteed payments represent earned income to the members, thereby qualifying them to enjoy the benefits of tax-favored fringe benefits. The members' share of bottom-line profit is not considered earned income because the members are considered to be inactive owners; therefore, the members do not qualify for special tax-favored "fringe benefit" treatment.
A corporation can be a member of an LLC. This allows you to create an additional level of ownership, which is designed to create an entity that can offer such traditional fringe benefits as retirement plans and an additional level of protection from liability.
The managing member of an LLC can deduct 100 percent of the health insurance premiums he or she pays--up to the extent of their pro-rata share of the LLC's net profit, because the profit is considered earned income. Note: If a member has earned income, he or she will also qualify.
In closing, if the state where you intend to operate has enacted a law allowing the creation of LLCs and you could use the features it offers, yet you don't want all of the pape work and costs associated with incorporating, equip yourself with an attorney and ask him about the pros and cons of creating a LLC and if it's best for your situation. Additionally, local bookstores or libraries can be of service to you.
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